World's Great Excess of Supply

My recent book, Era of Large Excess Economy, examines the world's supply-demand balance as an underlying factor of intensifying sentiments for anti-globalization and curbing migration, as seen in developments since 2016 such as Brexit (Britain's decision to leave the European Union) and the inauguration of Donald Trump as the U.S. president. The sudden drop in crude oil prices in early 2016 and the ongoing negative interest rate trend in Japan and Europe could also be explained from the perspective of excess supply of energy and money.

Since the bursting of the economic bubble in 1990, Japan has had to spend a lot of time processing the excess supply of labor, production capacity and debt. What has been happening to the world economy since the collapse of Lehman Brothers is, indeed, the global version of Japan's post-bubble struggles, characterized by the structural excess of labor, goods, money, and energy.

In the 2000s, low- and middle-income economies enjoyed some of the strongest growth in the post-war era until the collapse of the economic bubble. This was largely attributed to the fierce increase in exports from emerging economies, mainly in Asia, in response to the establishment of a global framework facilitating greater industrial production, led by China. Other factors include the subprime lending boom in the United States, the Chinese economy experiencing 10% growth, and price surge of crude oil and other resources. The emerging and developing economies' share in world trade also rose rapidly up until about 2010.

However, such factors that supported the strong growth of the world economy have gone and left developed nations and emerging economies to compete for a greater share in world trade. While emerging and developing economies have managed to restore a positive supply-demand balance, developed nations continue to suffer excess supply and demand shortfall.

In the post-Lehman world economy, the slower growth and economic disparity between countries have increased discontent among both developed nations and emerging economies, potentially triggering friction in international trade and foreign exchange. This tendency is becoming particularly evident in the United States, which is suffering from a massive international trade deficit.

There is a structural excess in the balance of supply and demand for labor, goods, money and energy, respectively. With regard to goods, developing nations have always taken an export-led approach to boost their growth. Developed nations are prone to losing production opportunities, which undermine their trade balance.

Similar situations are observed with regard to the excess of labor. The increase in income and education level in emerging economies especially in middle-income countries has made it easier for their citizens to immigrate globally on their own costs, resulting in a dramatic surge in immigration from emerging economies as well as middle-income countries, rather than primarily from low-income countries as was the case in the past. This trend is expected to further accelerate, potentially provoking negative sentiments against immigrants in some developed nations.

As for the excess of money, the combined money supply of the Organisation for Economic Co-operation and Development (OECD) members and BRICs (Brazil, Russia, India and China) nations now surpasses the global gross domestic product (GDP), following the economic shock caused by the collapse of Lehman Brothers. The situation remains unchanged today, as the world shifts from the age of money shortages to the age of abundant money circulation.

The same applies to the supply of energy. The U.S.-led shale oil revolution since 2008 has boosted shale oil production, and consequently brought down the price of crude oil. According to an announcement by the U.S. Department of Energy, shale oil production might increase further into 2040, diluting concerns about scarcity of energy resources.

Nothing positive would come about from competing for a larger share of the pie from economic growth between developed nations and developing countries, as it would leave developed nations with higher dissatisfaction and make developing countries unable to fulfill their full growth potential. One possible solution to create a win-win situation would be to generate an economic bubble. Trump's economic policies are expected to have a bubble-inducing effect, but that would only have a temporary benefit. Above all else, a bubble economy would have serious repercussions once it collapses, and therefore cannot be a final solution.

Let us then explore the direction of a breakthrough for the world economy by examining how Japan has dealt with three excesses it faced after the bursting of its economic bubble. The first was to solve the bad debt issues. Japan forcibly realigned banks and other corporations to reduce their excess supply capacity. The other was to take advantage of special demand from China and the digital industry boom to achieve the nation's economic recovery.

Today, even though China is no longer boasting 10% growth, the world economy needs a special structural demand that aids its positive and stable growth. As for the digital industry boom, post-bubble Japan achieved economic recovery thanks to powerful help from worldwide popularity of Japan's DVD recorders and flat-panel television sets. Similar innovation could serve as a perfect driver for another economic recovery.

Having both developed nations and emerging economies compete in the same arena would undoubtedly result in discontent in international trade. At the same time, we are no longer in the age where the supply of goods is the only driver of economic growth. In order to sustain positive long-term growth in the world economy, it is essential for developed nations to create major innovation for a breakthrough, and differentiate themselves from emerging economies in areas other than the supply of goods.

In terms of income balance, developed nations have a competitive edge over emerging economies, gaining surplus from service exports and primary income. President Trump of the United States, a major power in the developed world, does not speak ill of service income and primary income, despite his vocal criticism of trade balance. That means Japan is also almost free to build up surplus in these areas.

As for excess supply of money, the economy has played a main role while finances were in a supporting role. Now that the money supply has increased to an excessive level, finances should be considered more than before as a solid income tool at a standard equivalent to that of the economy. Finances represent a field of strength particularly for developed nations, contributing to a surplus in the balance of primary income. With regard to energy, the sense of energy's scarcity is becoming diluted due to the 21st-century energy revolution, which is expected to reduce energy constraints with respect to energy volume and energy producing regions.

The Fourth Industrial Revolution also represents a main direction of breakthrough. If technological innovation generates brand-new demand and investment opportunities worth a large sum of money, both developed nations and emerging economies will gain some room for new growth. Past industrial revolutions were all associated with the energy revolution. The same seems to apply to the latest wave of industrial revolution with renewable energies and non-conventional petroleum resources. It is important to take full advantage of it.

In order to put the world economy on to a positive growth track as a whole and give greater affluence to the world, rather than letting developed nations continue to earn profits from emerging and developing economies, it is important to build a social system that promotes innovation and turn it into economic growth.

In the case of Sweden, for example, the government offers generous social security, quality education (the world's highest ratio of government spending on education against GDP), and an active labor market policy to strengthen the nation's human resources, thereby boosting its innovation-creating capability and achieving a growth rate of over 4%, on par with emerging economies in 2016. Advancement of human resources leads to the promotion of innovation, and is therefore a mechanism for approaching the Fourth Industrial Revolution.

Singapore has achieved economic growth with powerful government-led initiatives to advance its industries. Today, it is going one step ahead of the Fourth Industrial Revolution by advocating the Smart Nation Vision, in which Singapore strives to become the world's first nation to connect its basic infrastructures and day-to-day infrastructure services with the Internet of Things (IoT). The nation's per-capita income is now more than double that of Japan.

International collaboration is another direction for further developing the world economy. In relation to the latest French presidential election, opinion polls show that public confidence in France's new pro-EU President, Emmanuel Macron, is low when it comes to immigration and other issues that cannot be easily resolved by France alone. This indicates that, in order to resolve various social and economic issues in France, the new president must be able to exert influence not only domestically but also on the EU.

International frameworks are also effective from the perspective of promoting growth with globalization. One such example involving Japan is the Trans-Pacific Partnership (TPP). If it manages to improve or resolve social and economic issues within Japan, it has the potential of making our economy grow and enriching our society.

What has been discussed about the balance of primary income and the Fourth Industrial Revolution also applies to Japan. During the lost two decades, Japan suffered a low growth rate and a negative balance in supply and demand. However, it should not be overlooked that, even during those days, Japan managed to consistently gain surplus in the balance of primary income.

It is important for Japan to continue achieving this surplus in primary income. To this end, it is essential for Japanese companies to enter into overseas markets to gain overseas earnings and expand investments in foreign securities. While China has the largest reserve of foreign currencies, Japan holds the world's largest net foreign assets in terms of external financial assets and liabilities. If that is the case, Japan should squarely take on achieving greater gains in that area.

Of course, if companies' profits are reserved internally, it would not benefit the economy. It is not good enough if only the wealthy become even wealthier. It is important how the wealth can be repatriated and redistributed within the country.

Another essential task is to further accelerate innovation. Among OECD members, Japan has the second largest ratio of domestic value-added content in exports. In other words, value-added contents, produced domestically, represent a high weight in Japanese exports. Topping the ranking is Australia, which has a high ratio of domestic value-added content because of its focus on exporting domestically-mined resources. Japan is effectively the world's No.1 among countries that focus on exporting industrial products, and is actually performing well in world trade.

However, by category, the ratio of research and development (R&D) is low within value-added export contents. Japanese small- and medium-sized enterprises, in particular, do not invest in R&D compared to those in other major developed countries. This should be expanded to build up fundamental strength.

As for excess of money, deposits at financial institutions represent a large proportion of Japanese households' financial assets. This may be reflective of the Japanese people's conservative approach to household finance. Yet, in other words, there is room for utilizing such money for the purpose of generating greater wealth and improving their standard of living.

Furthermore, regarding the Japanese companies' capital investments, the ratio of capital investment to GDP is higher than that of major Western countries, but their ratio of IT investments within capital investments is quite low. Since 2000, the IT investment ratio to GDP has remained steady, but the ratio of non-regular employment has increased. What it might mean, in principle, is that Japanese companies have prioritized utilizing cheap and flexible labor over making IT investments since 2000. Fortunately, today's labor shortages have created an ideal opportunity for promoting IT investment. Japanese companies must invest more in IT to boost productivity, so as to achieve a breakthrough in the Fourth Industrial Revolution.

In this sense, the development of an ultra-smart society, one of Japan's growth strategies in the Abenomics, could precede the breakthrough of the world economy. Artificial intelligence (AI) and other technologies can deliver advanced social systems. For example, combining the technologies for self-driving cars and solar energy systems could bring about an energy self-sufficient car that self-drives anywhere in Japan. Such a vehicle could resolve transportation inconvenience, for example, in depopulated communities. In recent days, there have been urban residents with no convenient accessibility to supermarkets or other stores nearby. Establishing an ultra-smart society could offer a more convenient way of shopping, thereby resolving their difficulty and potentially generating new demand.

Moderator:
In Japan, some argue that the increase in the ratio of aged population could hinder productivity increase using IT due to the issue of IT literacy. In your book, you pointed out that Sweden has achieved a higher rate of productivity increase than Japan, and that a strong productivity increase can still be achieved in an aging society, highlighting the importance of educational investment and active labor market policies.

Some studies suggest that about half of all occupations will disappear in the next 10 to 20 years as a result of the Fourth Industrial Revolution. It is an urgent task to shift our focus to value-added occupations that cannot be replaced by robots.

Japanese companies have made an aggressive shift to non-regular employment, which could be easily replaced by AI and robots. This approach may have had some rationale for Japanese businesses, but it has cast a dark shadow over the nation's future outlook. Our key challenge for the future is to increase productivity and economic growth by making educational and human resources investments and further upgrading human resources.

You have rightfully pointed out that both businesses and households are risk-aversive. Against this background lies the pitfall of preconceived ideas. Since the bursting of Japan's economic bubble, the idea that good companies are those with no debt and no bankruptcy outlook has spread and taken root deep in our society. However, failure to make sufficient investment would turn such companies into losers with no competitive edge.

There also has been a deep-rooted perception in Japan that the population decline would contract domestic demand, making it unwise to invest. There are three directions as a solution. The first direction is to raise wages. Increasing the standard of income would keep domestic demand strong even if the population declines. The second direction is in regard to foreign trade. Japan has promoted the TPP for this reason. Even the TPP11, minus the United States, has the effect of increasing domestic demand. The third direction is to initiate the Fourth Industrial Revolution to spread new lifestyles for generating greater demand. This is the main theme of the government's growth strategy, amended this year.

Let me ask you one last question. In your book, you said the shift of the world economy from an era of shortage to an era of excess will give price-determining power to consumers. Are you suggesting that there will be downward pressure on prices worldwide, triggering deflation or disinflation? In the era of excess, how long do you think the trend of low inflation and low interest rate will continue?

Nakajima:
During the transition of the world economy from an era of shortage to an era of excess, there is always a possibility that even advanced industries of high value added could experience a structural excess in their supply capacity. This would result in the easing of the supply-demand balance, which, in turn, gives extra price-determining power to the demand side.

In addition, while the supply capacity is in excess, consumer prices do not rise in principle. This creates the tendency of excessive competition, which is not good news for industries, businesses, and workers. Accordingly, monetary and fiscal policies alone cannot fully resolve today's disinflation, low interest rates, and slow-growth trends. We need a breakthrough.

Without a breakthrough, the current cycle of slow growth alternating with moderate growth will continue for the foreseeable future, maintaining the structural trend of supply excess. Seven or eight years have passed since the Lehman Brothers collapse. Slightly more stagnant economic conditions in and outside Japan and global disinflation could persist for five more years or so.

A breakthrough provides a major seed of growth for the world economy as it strives to reach the next significant stage of growth. For this reason, even though the bubble economy is not desirable, we must embrace the digital industry boom and the Fourth Industrial Revolution as a major part of it.

Q: Why is it that Japan has the world's second-highest ratio of domestic value-added contents in exports? Does it have anything to do with the "not invented here" attitude?

Nakajima:
It has a lot to do with the industrial structure of post-war Japan. There is nothing wrong with the "not invented here" attitude itself. Since neighboring Asian countries lagged behind Japan in terms of the level of industrialization in those days, Japan did not have enough room to attempt an international division of labor in the process of enhancing its industrial structure. In today's economy, the ability to add significant values within the country is a positive property, but it may leave the possibility that Japan does not fully utilize beneficial resources, know-how, and industrial products available in the rest of the world. Remaining tasks include building an international framework that caters to the age of globalization, and embracing the entry of foreign companies into the domestic market as a way of boosting the vitality of Japanese businesses.

Q: Personally, I believe the biggest problem is the excessive supply of money. Is there any solution?

Nakajima:
There is a strong belief in Japan that finance underpins the economy. However, we must pursue the approach of having finance generate value added. Also, in view of the need to distribute wealth, it is necessary to consider, for example, abandoning separate withholding taxation and adopting a comprehensive taxation system instead.

Q: Would the Fourth Industrial Revolution boost productivity even further to continue expanding the excessive supply of goods? Or would it promote streamlining and appropriate allocation, eliminating inefficiencies to contract the supply of goods?

Nakajima:
I don't believe the Fourth Industrial Revolution would eliminate the bubble economy as an economic structure. There is no stopping the excessive supply of goods or trend toward an economic bubble. Yet, at the time of a breakthrough, there is an absolute shortage in supply and demand. When the Industrial Revolution occurred in Britain, the industrial world became capable of achieving what they had not been able to before, thereby triggering an unprecedented level of growth. In post-WWII reconstruction, there were phases of strong growth in world economy, led by developed nations, in the cycle of 15 to 20 years. The greater the scale of breakthrough is, the bigger the scale of bubble-free economic growth we can expect to see, arriving in the cycle of several scores of years.